As of 1 January 2019, as a result of Hungary adopting the provisions of Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market i.e. the ATAD I Directive, new interest deduction limitation rules entered into force in Hungary. The former, equity-based corporate tax rule on thin capitalisation was replaced by a provision on limiting interest deductions based on EBITDA (earnings before interest, taxes, depreciation and amortisation). The purpose of the new legal regulation is still to discourage intra-group tax base erosion and profit shifting practices.
The new regulation introduced the concept of net borrowing costs which, taking a profit & loss approach, considers the “expense” balance of borrowing costs and (taxable) interest and similar income (financing costs higher than interest-type income). Net borrowing costs defined above can be claimed in the corporate tax base up to 30% of EBITDA or HUF 939,810,000 (roughly EUR 2.9 million), whichever is higher.
Applying the new interest deduction limitation rules is mandatory in Hungary from 1 January 2019, but for financing contracts concluded prior to 17 June 2016, the new rules are only applicable from an increase in the financing amount and/or an extension of the term (in respect of the modified amount or term). The new interest deduction limitation rules may also be applied in respect of the period preceding the modification should the taxpayer decide to do so. This can be an option if the new interest deduction limitation rules might result in a more favourable tax base position for the taxpayer.
The interest on liabilities to financial institutions (banks, credit institutions) used to be ignored for the purposes of thin capitalisation. However, through net borrowing costs, the provisions effective from 2019 will include all types of interest expense in calculating the new tax base modifying item. So even businesses that fully finance their activities from financial-institution loans and thus formerly did not have to apply the thin capitalisation rule can be affected by the interest deduction limitation.
When defining borrowing costs, the new interest deduction limitation rules mean that not only expenses qualifying as interest are taken into account, but also costs and expenses that are equivalent to interest from an economic point of view, as well as costs and expenses incurred in connection with the raising of finance. Guarantee fees related to a financing scheme as per the non-exhaustive list of the ATAD I Directive as well as transactional fees and other, similar costs related to the use of funding fall into this latter category.
In the case of financing between related companies, the amount of any adjustment necessary from a transfer pricing perspective – due to deviations from the arm’s length price – still has to be considered as deemed interest expense or income when determining net borrowing costs.
As for businesses involved in group financing, if they achieve a profit on intra-group financing (received and given loans) it is important that they still do not have to apply the rules on limiting interest deductions. This means that if taxable interest and equivalent income from an economic point of view exceed business-related financing costs, the interest deduction limitation rule does not have to be applied (this case there are no net borrowing costs as per the relevant laws).
What about tax groups?
Starting from 2019, tax groups can be created not only for VAT but also for corporate tax purposes. In the case of tax groups, the rules on limiting interest deductions have to be applied separately for each group member. The general limit of HUF 939,810,000 (roughly EUR 2.9 million) can be taken into account by the group member based on its net borrowing costs relative to the net borrowing costs at group level. At the group member and compared to the general rules this may result in a lower general limit.
Expected impacts of the new interest deduction limitation rules
Given the average borrowing costs of Hungarian businesses it is likely that the majority will be able to claim their full net borrowing costs in the corporate tax base under the new interest deduction limitation rules (if this does not exceed the HUF 939,810,000 – roughly EUR 2.9 million – limit).
However, the new rules may result in a worse corporate tax base position for businesses with low EBITDA but high or extremely high net borrowing costs. Case-by-case reviews are needed to optimise operations and to identify related risks. Should you wish to entrust such a review to an expert, please do not hesitate to contact the tax consultancy team at WTS Klient Hungary. We will be happy to assist you.